Earlier this month, the UK Government announced the introduction of a Help to Buy ISA to help first-time buyers purchase their own home. For every £200 that you save towards a property, the Government will add £50 (or 25% of whatever you save up to £50). The government will continue to top up your savings until their total contributions reach £3,000. The scheme is being touted as a way to help first-time buyers save for their property tax free. Whilst this may sound like a good way to stimulate savings, it's likely to fail in the long run as house prices continue to rise. Should you hold off buying a property and save for a bigger deposit, or is it worth getting on the ladder earlier with Help to Buy? We look at the benefits and problems of the young scheme.
Help to Buy
Help to Buy 1 was introduced by the government in 2013 to help first-time buyers purchase their first home with just a 5% deposit. The government provides an equity loan (15%) for the rest of the deposit, so that you can put down a total of 20% of the house's value for the deposit and therefore qualify for a loan-to-value mortgage of 80% i.e. you can borrow less from the banks at a high interest rate and instead borrow from the government without paying interest on the loan for the first five years of your mortgage. You can purchase a new build property valued at no more than £600,000.
The second phase of Help to Buy is a mortgage guarantee scheme which can be used to purchase a new build or existing property with a price tag of up to £600,000. The government guarantees up to 15% of the loan at a cost to the lender, allowing the borrower to access cheaper mortgage deals.
The stats
- in the first 23 months of the first scheme, 44,741 properties were bought
- 82% of these were first-time buyers
- the average purchase price was £212,719
Benefits
The first scheme has proved successful amongst first-time buyers with a small deposit and who are willing to stay in the property for at least five years. At the time when it was introduced the prices of properties were rising rapidly and many were concerned that the scheme would spur this on. Almost two years on and, despite a slowdown, the cost of houses keeps on rising.
Problems
1) Raising the 5% deposit
In 2014, the average cost of a home was £272,000. Putting aside the fact that the average cost varies depending on which part of the UK you live in, £272,000 means that to qualify for this scheme, you would need to have saved £13,600 for a 5% deposit. In the same year, the average salary was £26,500. After paying tax, you would receive just £1700 (not taking into account if you are paying off student loans or contributing to a workplace pension). If you saved 10% of your net salary, it would take you about 7 years to save for the deposit, whereas a more aggressive saving rate of 20% would mean you could afford the 5% deposit in just over 3 years. Raising a 5% deposit outside of London is feasible for many and with this at the core of the Help to Buy scheme, it's improved the affordability for many people. With low interest rates on savings, it's taking most a lot longer to save up for a deposit.
2) Borrowing interest free
The government lends you the 15% to make up the rest of your deposit without charging you interest for the first 5 years. This is appealing to many as you get a bit of breathing space in the toughest years of house ownership. If, during the five year period, your house rises in value, the amount you will owe on the loan will also increase. Similarly, the cost of the loan will decrease if your house falls in value.
In the sixth year of the loan, you will start paying interest on the loan of 1.75%, but after six years, the interest rate will be 1% + any increase in the retail prices index (RPI, a measure of inflation). RPI is pretty low at the moment at just 1.1%, so this works in your favour for now, but it's impossible to predict what this may be in 7 years time.
Whilst an interest-free loan is enticing, there are restrictions that come with schemes like Help to Buy. The first scheme is only for new build properties. As someone who believes in the sturdiness of older properties and with enough experience living in new builds to know they're not of high quality, this has put me off of Help to Buy 1. New builds are not made to last in the same way that older buildings are and shortcuts made by the builders don't show up until a few years later meaning you could be saddled with some costly repairs or the value of your property goes down as a result.
3) Affordable mortgage
Saving for the deposit is a big task and the thing that we tend to focus on, but it can be easy to forget the accompanying increased costs of living that hit you when you start paying off your mortgage. As a rule of thumb, you should be able to pay your mortgage with 1/3 of your net salary. Looking at the most competitive mortgage (at the time of writing: March 2015) you would be looking at paying £890 per month for the first two years. If you are earning £26,000 (or £1700 a month after tax), then your mortgage payment for the first two years, when the rate is geared in your favour, will be 52% of your after tax salary. That would leave you with just 48% or £810 for all other bills, food, petrol and clothes. After two years, that 52% jumps to 79% when you start paying £1346 per month for the mortgage.
There are other costs to factor in too: solicitor's fees, survey fees, stamp duty and moving/buying furniture.
4) Rising rents
Rents continue to rise with no signs of the government introducing a cap to stop landlords from pushing rents even higher. Renting will remain unpredictable for the majority who are saving for their first property. More people will be sharing a house with more people for longer to save enough money. Even if they save enough for the 5% deposit in 3 years' time, the house prices may have risen to the point that the deposit is now just 3% of the property's value.
Conclusion
Help to Buy will continue to help many on to the property ladder, but at what cost in the long run? Will there be enough government funding to cover demand and what will the retail prices index be in 7 years time? Schemes like this are always introduced with good intentions, but taking part means taking a leap of faith that the odds will be stacked in your favour. You want the value of your house to increase in the long run, but are you going to be able to afford the loan increase too? Have you considered the cost of the mortgage after the first two years? Can you really afford it?
Whenever a scheme like this is introduced, I don't rule it out immediately, but I'm very skeptical of its suitability for a DIY-investor like me. There are aspects of Help to Buy that aren't quite clear, so like any other financial decision, if I don't fully understand what I'm signing up for then I can't take part. I will have to continue to work on my savings to buy a property in London with a 20% deposit. I have a long way to go and I may see many peers get on the ladder before me by using Help to Buy, but I will be buying a property on my terms and not as a joint agreement with the government.
I'm also working on the other aspects of buying my first home.
All information provided at Life-Life Balance is for informational purposes only. MM is not a qualified financial advisor. Before making any decisions on your finances you should seek advice from a qualified advisor.
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